Understanding the Flaws in a Premium Financing Policy

When I was a poor starving college kid, I sold my motorcycle to a guy for $300. Turns out the check bounced, so he had the motorcycle, and I had nothing. He wouldn’t give it back, so I went to small claims court. It may not seem worth it for the money, but 300 bucks was a lot to me back then, and I needed to eat.

At the courthouse, the judge looked to the other guy and asked his story. After hearing the guy’s side, the judge ruled in my favor. I never opened my mouth. You can imagine how ridiculous the situation was when I didn’t even have to present my side of the story.

I’ve written at length about how little the typical consumer understands about premium financing. A part of my job has been to vet deals and fix problems. But even I was surprised earlier today when I had a scheduled phone call with a client who retained me to review his deal.

The phone call consisted of the insured individual, the premium finance guys, myself and my associate. In a way, the client was the judge, and respectively, the agent and I were the defendant and plaintiff, though I didn’t mean for it to be adversarial. That being said, I didn’t think it was a good idea for the client to move forward based on what I understood as his goals relative to what I was seeing. All I proposed to do was to bring objective information to the table.

This wasn’t an initial call to discuss the deal with the client. This transaction had been going on for over a year, and the client and his wife were fully underwritten and ready to go. I was brought in at the last minute. When I asked the client where he wanted to start, he said he wanted to give the other guys a chance to “defend” themselves regarding the points my associate and I had brought up. A few minutes into the conversation, the client stopped them and said it wasn’t what he understood and closed it down. I never opened my mouth. All the data and support material I had lined up was for naught. We never discussed it.

A Change of Heart

What made it turn so quickly? It wasn’t the sensitive nature of the indexed universal life contract that was illustrated too aggressively for my taste. It wasn’t that the illustrated financing rates were too conservative in my opinion. It was that the client had a fundamental misunderstanding of the risk and what was on the line. He didn’t even know he had to put up substantial collateral for the financing. He thought there was actually no risk besides a few out-of-pocket interest payments. This is so shocking, it belies belief.

I’d run multiple alternate scenarios to show how sensitive the contract was to minute changes in assumed interest. I’d explain how the illustrated interest rate wasn’t as conservative as he thought because the index rate doesn’t incorporate dividends. I used third-party tools to put the assumed policy return into context. I’d performed independent modeling to show the marginal likelihood of the policy panning out over time in a stock market with a variance in returns that couldn’t be illustrated by the insurance company. I’d calculated how a reduction in crediting rate for the policy would manifest itself by a 300 percent reduction in policy values due to policy costs and expenses.

I’d created my own spreadsheet like the client had been originally presented but added a column showing the policy loan (at a conservative rate though the loan rate was variable) that I don’t think the client even knew would exist. I was going to show how borrowing and collateralizing $14 million plus accruing interest from a bank to buy $20 million of insurance was pinning hopes on the policy performing well enough over 20 years to pay back a $27 million loan to the bank through a loan from the life insurance policy. I planned on showing how that policy loan would grow multiple fold on its way to $80 million by age 100, even if the low variable policy loan rates never changed. I wanted to point out that at actuarial life expectancy, when the loan was $50 million the net policy death benefit to his family was projected to be $10 million. I intended to show a ledger at what I considered to be more reasonable crediting assumptions that showed the entire deal was likely unsustainable and would collapse. I was going to explain that if things went sideways there would be tax at ordinary rates on tens of millions of dollars of phantom gain.

But I didn’t get to. The judge ruled in my favor without me opening my mouth.

Bill Boersma is a CLU, AEP and LIC. More information can be found at www.oc-lic.com, www.BillBoersmaOnLifeInsurance.info and www.XpertLifeInsAdvice.com or email at bill@oc-lic.com.